Vol 12 (2015) - Issue 5

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Why Corporate Insolvencies Will Remain High in 2015

During the first quarter of 2015, apart from the Eurozone and Japan, GDP growth eased in all major economies: U.S.’ output contracted, BRICs markets lost momentum with China decelerating and Brazil and Russia remaining in recession. Outside the U.S, policy makers of the biggest economies stepped-up easing measures, but these have not translated yet into a strong pick-up of activity. Business surveys point to a fragile recovery and there is little chance of significant upturn, at least until the end of the year. Global GDP will probably grow around +2.7% in 2015 (same as last year), below +3% for the fourth consecutive year. Globally, we see risks for companies will come from (i) fragilities in Emerging Markets demand, (ii) ongoing disinflationary pressures, (iii) adverse effects of upcoming FED tightening and (iv) rising political risks. We estimate globally that insolvencies will continue to decline but at a slower pace (–2% y/y) than previous years in 2015, and still remaining +6% above their pre-GFC level.

Demand pick-up is modest reflecting weaker growth in Emerging Markets. In the US, real consumption is picking up speed, driven by an increase in disposable income and improving consumer confidence which should lead to a +2.5% growth rate expected in 2015. In the Eurozone, business confidence is recovering reflecting strong service activity and encouraging trend in the manufacturing sector. GDP could rise by +1.4% (from +0.8%). In Europe and the US, prospects for employment and new orders will improve as a result but a lot of companies remain exposed to increases in input prices due to the lower euro and increasing wage bills while still facing downside pressures on selling price. Emerging Markets face a tougher outlook. Apart from India, which is likely to accelerate above +7.5% this year, the other BRIC economies are set to go through tough headwinds. Russia is in recession (–4.0% in 2015) as a result of difficult financing conditions and economic sanctions. In Brazil, activity will continue to suffer from high cost of credit and high Inflation. We expect Brazil to be in recession in 2015 (–1% GDP growth after +0.1% in 2014). In China, the move from quantity to quality is painful with private consumer growth failing to compensate lower exports and weaker investment growth. After +7.4% last year, GDP is unlikely to reach the government 7% target.

Downward price pressures remain an issue. Disinflationary pressures which emerged in 2014 will remain globally and for a longer period than perhaps most had anticipated, meaning that companies will struggle to maintain their prices. This is true for commodity producers who continue to bear the brunt of the drop in commodity prices (–33% y/yin June 2015). But also for large manufacturing producers such as Chinese and South Korean companies who continue to suffer from moderate improvement in global demand in a context of structural overcapacity: in China, producer prices contracted for the 40th month in June 2015! Even some services are now experiencing such trends. Looking at transport for example, the Baltic Dry Index (reference index aggregating prices for twenty shipping routes) has reached its lowest level in 30 years amid massive oversupply (number of active vessels) and lower (mainly Chinese) demand. This disinflationary context is expected to last probably longer than most would have though and will create issues for companies in the most exposed sectors that are not able to adjust their financial model to the lower prices.

Upcoming FED tightening poses significant risk for global liquidity and currencies stability. Despite FED tapering, global liquidity is still ample. The Bank of Japan and the Eurozone Central Banks are pursuing their quantitative easing programs. And other major Central Banks such as Australia, Korea, India and China have eased their monetary policy through several rate cuts since the beginning of the year. This has contributed to lower the cost of credit globally which should support a rise in investment. But so far, this positive dynamic is not entirely visible and it seems that financial assets are those which have benefited the most of these easing measures. Reasons for this are probably the uncertainties surrounding the demand outlook, which undermines business confidence and limits the desire for higher capital expenditures. Another reason may be the anticipation of the FED rate hike by the end of the year. A rate hike by the Fed makes USD-denominated investments relatively more attractive and investors usually respond by reallocating their portfolios away from Emerging Markets. The impact means lower liquidity supply (in USD terms) available for the rest of the world, higher risk of currency depreciation for countries with weak fundamentals.